IFRS 16 Leases (“IFRS 16”) replaces IAS 17 Leases (“IAS 17”) and the related Interpretations: IFRIC 4 Determining whether an Arrangement contains a Lease, SIC-15 Operating Leases – Incentives and SIC-27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease.
IFRS 16, which applies to periods beginning on or after 1 January 2019, sets out a comprehensive model for the identification of lease arrangements and their treatment in the financial statements of both lessees and lessors.
The requirements of IFRS 16 are comprehensive and, in many places, complex. It is advisable, therefore, to refer to the standard itself to determine the correct accounting treatment for any item or transaction.
Accompanying IFRS 16 are twenty-four ‘illustrative examples’, which illustrate aspects of the new standard but are not intended to provide interpretative guidance.
Core principles and summary of changes from previous standards
IFRS 16 establishes principles for the recognition, measurement, presentation and disclosure of leases, with the objective of ensuring that lessees and lessors provide relevant information that faithfully represents those transactions.
The standard provides a single lessee accounting model, requiring lessees to recognise assets and liabilities for all leases (whether they would be classified as “operating” or “finance” under IAS 17) unless the lease term is 12 months or less or the underlying asset has a low value.
This model requires recognition of:
- a “right of use” asset, to reflect the lessee’s right to use the leased asset for the lease term; and
- a lease liability, to reflect their obligation to make lease payments.
This fundamentally changes the accounting treatment for leases that are classified as “operating” under IAS 17. Lessors continue to classify leases as “operating” or “finance”, with IFRS 16’s approach to lessor accounting substantially unchanged from IAS 17.
IFRS 16 also changes the definition of a lease compared with IAS 17. This is driven much more by the question of which party to the contract controls the use of the underlying asset for the period of use.
There may be some contracts that were accounted for as leases under IAS 17 but which fail to meet the definition of a lease under IFRS 16 because of increased focus on the need to control an identified asset. In these cases, the contracts would be accounted for as service contracts.
IFRS 16 allows lessees and lessors to apply the standard to a portfolio of leases with similar characteristics if the entity reasonably experts that the result will not be materially different from applying the standard to each individual lease. In addition, it introduces significant new disclosure requirements, particularly for lessees.
The new regime will have significant implications for your business if you are an IFRS-preparer with a substantial operating-lease portfolio. Please contact Stephen Drew at Smith & Williamson for further advice.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.